Download ECN 111 PRINCIPLES OF MACROECONOMICS HOMEWORK 6

ECN 111
PRINCIPLES OF MACROECONOMICS
HOMEWORK 6 (CHAPTER 13) PROBLEMS
DUE: THURSDAY, NOVEMBER 13, 2014
Same rules as before:
1. You may submit an assignment with one name or with two names.
2. If you and a partner submit the assignment together, you must both be from the
same section. You will both receive credit.
3. You must submit the homework assignment in your correct section.
4. The assignment can either be hand-written or typed on a computer—I don’t care
as long as I can read it.
5. Assignments will be collected at the end of class on the due date. They must be
submitted by the end of the class period. No Late Assignments!
6. Please staple your homework pages together with this page on top.
By signing below, I pledge my word of honor that I have abided by the
Washington College Honor Code while completing this assignment.
NAME # 1: _______________________________________
WASHCOLL EMAIL: _____________________________
NAME # 2 (optional): ________________________________
WASHCOLL EMAIL: _______________________________
PLEASE CIRCLE YOUR SECTION:
10 (111 William Smith Hall; 11:30 – 12:45 PM)
11 (113 William Smith Hall; 1:00 – 2:15 PM)
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*THIS IS THE LAST HOMEWORK ASSIGNMENT OF THE SEMESTER*
1. [4 points] In 2001, during President George W. Bush’s administration, he lowered personal
income taxes for all individuals (↓ T). Explain how this “expansionary fiscal policy” affects the
aggregate demand (AD) curve. I want you to explain the intuition both in words and using your
AD graph.
2. [4 points] In class, I talked about why the short-run aggregate supply (SRAS) curve might
slope upward. Even though this chapter is all about the classical explanation of business cycles,
this innovation in economic theory is thanks to the ideas of John Maynard Keynes. That’s why
we call it a “Keynesian” supply curve. Professor Keynes argued that the SRAS curve slopes
upward because in the short-run prices are not “flexible” like Adam Smith and the classicals
assumed, but rather, they were “sticky.”
What exactly are “sticky” prices? List and explain the three primary sources for “stickiness” that
your textbook mentions. Be specific and make sure to explain how long-term contracts
contribute to “sticky” prices.
3. [6 points] This question relates to an aggregate demand shock in the short-run. Using
your (static) AD-LRAS-SRAS graph, what happens in the short-run if the Federal Reserve
follows a “contractionary monetary policy”? This means that the Federal Reserve raises the
nominal (↑ i) and real (↑ r) interest rates in the economy.
As you draw your graph, first assume that your economy begins at a general equilibrium (call
this initial equilibrium point A), where the AD-LRAS-SRAS curves are all intersecting at the
full-employment level of potential GDP.
Use your graph to show me what happens to your aggregate demand curve, the price level (P),
the short-run equilibrium level of GDP (YB), and unemployment (u).
When you compare actual short-run output to potential GDP, is your economy in a recession or
an expansion?
4. [6 points] This question relates to an aggregate supply shock in the long-run. Using your
(static) AD-LRAS-SRAS graph, what happens in the long-run if the economy suffers a negative
supply shock (i.e., the price of oil rises up to $150 per barrel again)?
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To answer this question, first show me how the SRAS curve shifts because of the shock and what
happens to the economy in the short-run. Then, explain how the curves will shift again to get the
economy back to your long-run equilibrium at potential GDP.
NOTE: I need you to not only draw a graph and curves, but also explain in words the intuition
behind your analysis!
5. The table below shows the initial aggregate demand, short-run aggregate supply, and long-run
aggregate supply for a small economy. Assume this is the simple (static) model!
Price Level
AD
SRAS
LRAS
1.0
$13 trillion
$11 trillion
$12 trillion
1.1
$12 trillion
$12 trillion
$12 trillion
1.2
$11 trillion
$13 trillion
$12 trillion
1.3
$10 trillion
$14 trillion
$12 trillion
1.4
$9 trillion
$15 trillion
$12 trillion
a) [3 points] Graph the AD, SRAS, and LRAS curves for this economy on the same set of axes.
Label the initial long-run general equilibrium point “A”. What is the initial equilibrium level of
real GDP (YA) and price level (PA) for this economy?
b) [2 points] Suppose that government purchases in this economy increase (↑ G) so that
aggregate demand increases by $2 trillion at every price level. Draw the new aggregate demand
curve (AD2) on your graph in part (a). Label the new short-run equilibrium “B”. What is the
short-run equilibrium level of real GDP (YB) and price level (PB) at this short-run equilibrium?
c) [3 points] Why isn’t point “B” a long-run general equilibrium?
expansionary or recessionary gap exists.
Explain whether an
d) [2 points] This is an example of the simple (static) model. As time passes, what happens to
move the economy back to its long-run equilibrium? Illustrate this process in your graph in part
(a) by adding any other curves that you need. Label the new long-run general equilibrium point
“C”. What is the new equilibrium level of GDP (YC) and price level (PC) in the long-run?
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